Crude Oil Complacency Climbs

US production at 18-month lows was partly behind the recent surge in crude oil prices following yet another report of building onshore inventories. Despite the veritable flood of crude oil prices hitting global markets, crude prices continue to rise amid rising speculation that key global producers will elect to increase production even further. Since the freeze deal fell through, Russia has underlined its doubts that any such agreement will be possible, potentially paving the way for OPEC members to further stray from a single policy, opting instead to put national interests ahead of economic rationality. While prices have jumped to the highest levels since November on new forecasts that anticipate a rebalancing of the market my 2017, complacency amongst traders continues to grow as problematic fundamental conditions remain intact.

A Rebalancing Act

Comments earlier from IEA Executive Director Fatih Birol give credence to the idea that the ongoing low price environment is impacting production across the globe negatively, especially for higher cost extraction operations. According to Birol, non-OPEC suppliers will see output fall to the tune of 700,000 barrels per day this year. Much of this is coming thanks to reduced investment in the industry as low prices eat away at profit margins for exploration and production companies. In the United States in particular, data released yesterday by the Energy Information Administration showed that output fell 8.953 million barrels per day, the lowest since October of 2014. However, the one caveat to the market reaching his forecasted equilibrium in 2017 is the emergence of any major economic downturn.

Acting against any proposed rebalancing however are certain OPEC and non-OPEC producers such as Russia. On the heels of the Doha failure, Russia has come out on the offensive, hinting that production could rise even further towards the 12.000 million barrel per day level last recorded during the Soviet production era. Remarks from Russian Energy Minister Alexander Novak unequivocally highlighted this point, stating that oil production could exceed 10.800 million barrels per day this year. Additionally, he lambasted OPEC for failing to regulate its own production while calling for other global players to freeze output. However, the fractures within OPEC continue to grow, with the Saudi’s pledging not to freeze output without the participation of Iran, a condition that is unlikely to be fulfilled in the near future.

Outside of the fraying relationship between Saudi Arabia and Iran is the ability for the lost American production to be offset by rising OPEC production. Despite inventory concerns being largely shrugged off by markets despite the sheer size of the supply imbalance, should global onshore inventories continue to fill at the current pace, it could be a looming disaster for prices. Rising production from Iraq along with the potential for a rebound in Libyan output could add to oversupply concerns. Additionally, from the demand side of the equation, many of the existing forecasts anticipate growing demand, especially from emerging markets. However, slowing growth in China and uneven expansion in India may hamper those expectations despite the revision higher in forecasts from key industry groups like the IEA. While prices continue to trend higher, these factors could spell a forthcoming correction lower in crude oil.

Technically Speaking

Outside of the limited fundamental rationales for higher prices, technical indicators are pointing to levels that might be potentially unsustainable for WTI crude oil. Added volatility thanks to the steady flow of news headlines is creating a set of conditions that could potentially be ideal for swing traders with a multi-day view of markets. While some of the indicators are suggestive of additional upside potential, the relative strength index is adding to a growing sense of overvaluation. Although not above the key 70 level that would corroborate the idea of being overbought, the trajectory towards these levels is bolstered in part by the emergence of an upward trending equidistant channel formation since January.

The pattern channel pattern, which has a predominantly bullish bias, is reaching the upper channel line limit, supported in part by the 50-day moving average which is trending underneath the current price action. Typically when trading a channel, the best strategy is to follow the trend and not fight it. In this particular instance, initiating positions at the top of an upward trending channel is not necessarily wise due to shrinking reward potential and the confluence of the 200-day moving average acting as resistance against any sustained upside in crude oil prices over the short-term. From a longer-term perspective, the ongoing rebound may have merit as a technical rebound, but is still falling short of a full on reversal higher in prices. Should prices overcome resistance at $48.34 it could be the sign that a longer-term reversal is in place.

To Conclude

While fundamentally crude oil prices have limited reason to be trending at current levels, speculation of further losses in non-OPEC production and rising demand from emerging markets has been enough to offset the risks of rising inventories and production. While it may be too early to call for a rebalancing of the market as early as 2017 considering the factors contributing to present oversupply conditions, market sentiment continues to gravitate towards optimism despite growing complacency. While technical factors point to additional upside potential, chasing after recent gains might be premature considering the host of factors expecting a correction to momentum higher over the last few sessions. Should bullish sentiment prevail, a better entry point will be possible closer to the bottom of the channel while a break below the line could indicate a resumption of the prevailing downtrend and a reversal from recent highs.

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